Jeff Lewis, director of RobMac, considers what the impact of the reduction in inflation in December might have on the markets.
The UK December annual headline CPI inflation was reported at 10.5% down from 10.7% in November and a peak of 11.1% in October.
December annual core inflation (excluding food, energy, alcohol and tobacco) was 6.3%.
There is increasing evidence that UK headline CPI inflation has peaked and is being led down by lower energy prices. Its highly likely that this has a lot further to go. Natural gas prices have now fallen to below the pre-Russian invasion of Ukraine level and are down 19% so far in January. This should reduce the upward pressure in household energy bills with Petrol prices are also declining. The latest price of unleaded petrol on 17 January was £1.50 considerably down from the peak of £1.92 last summer. Expect lower energy prices to exert downward pressure on inflation, at least in next month or two.
Looking beyond the near term, slowing economic growth, along with higher taxes and rising mortgage rates, are likely to be a drag on real household take-home pay in 2023. Lower discretionary incomes should prove to be a significant headwind against another upward acceleration in inflation from here.. Its also important to note that the impact of supply chain disruption on prices in the goods market should begin to reduce as supply/demand effects are less out of kilter.
The Bank of England expects headline CPI inflation to essentially halve to around 5% by the fourth quarter of 2023. Even so, core CPI inflation (excluding food, energy, alcohol and tobacco) remains fairly sticky. The risk to Bank’s inflation outlook is the potential secondary impact of workers demanding higher wages to keep up with the high cost of living. With the unemployment rate still near an all time low , there is a possibility that higher wage rates become entrenched in the economy, increasing the risk of a wage-inflation upward spiral.
Given the current high rate of consumer price rises, the Bank of England will likely raise interest rates again at its next Monetary Policy Committee meeting on 2 February.
For investors, elevated inflation and likely negative GDP growth in 2023 are clear risks. However, the UK economy is not the equity market, and this probably explains why UK stocks gained nearly 17% more than the rest of the world in 2022, its biggest beat since 1990.
Moreover, UK-listed multinationals are largely linked to what goes on in the rest of the world. Looking forward, the reopening of the Chinese economy from Covid zero policy is a shot in the arm for externally focused UK companies. China seems to be willing to go for growth by relaxing restrictive policies applied to its all-important property sector. According to a report in early January, the Chinese authorities are set to raise lending caps for developers and extend the deadline for firms to meet debt limits. This could be a green light from the Chinese leadership to go for growth and should support overall UK firm’s growth prospects . Analysts are already starting to revise up 2024 UK growth expectations in anticipation of global economic recovery. Given low valuations, UK stocks can perform again this year.
* The value of an investment may go down as well as up, and you may get back less than you originally invested.
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